Cheat Sheet: How Regulators Changed Their Exec Comp Plan

WASHINGTON — The banking regulators made several critically important changes in their new plan released Thursday to restrict executive pay at financial institutions after their first attempt flopped in 2011.

For starters, the revised proposal casts a much wider net than the initial proposal. Rather than simply applying to C-suite executives, the plan additionally takes aim at "significant risk-takers" — a new designation designed to target employees who have the ability to place large bets for a firm or owe much of their pay to incentive-based compensation.

The regulators "are much smarter about how people get paid than they were five years ago," said Marc Trevino, a partner at Sullivan & Cromwell. "They really understand a lot more about how pay programs work, and I think the rule tries to set limits, but in a world that is much more complicated than the world they were imagining in 2011."

The new proposal also adds an additional tier to its structure, replacing the original plan's two levels with a third category that includes just the biggest banks with more than $250 billion of assets. Those institutions will be subjected to the proposal's toughest standards, while smaller banks face less onerous restrictions (banks with less than $1 billion of assets are exempted altogether).

That reflects a notable shift toward "tailored" rules by the financial regulators — a refrain meant to concentrate the brunt of regulatory requirements on the largest institutions and to lessen the burden on smaller ones.

Susan O'Donnell, a partner at Meridian Compensation Partners, said that the proposal is in some ways good news for the smaller banks because it limits their exposure to more proscriptive limits. But some aspects of the plan may be problematic, she said. By limiting the upside of incentive-based compensation, executives may have less reason to try to outperform.

"It is important that for the majority of (smaller) banks, these rules won't be cumbersome, but for banks over $50 billion in assets, the proposed requirements will likely require a meaningful shift in the pay mix and programs going forward — of course with potential for unintended consequences," O'Donnell said.

The revised proposal puts affected executives into two categories: top level executives like the president, chief executive officer, chief operating officer, chief lending officer and chief risk officer and so-called "significant risk-takers" who receive at least one-third of their pay from incentive-based compensation. Additionally, a risk-taker includes any individual who may commit or expose at least 0.5% of an institution's assets or who regulators specifically designate.

Risk-takers face different requirements depending on the size of the bank. For institutions with more than $250 billion of assets (Level 1), senior executives must defer 60% of their incentive-based pay for at least four years, while risk-takers defer 50% for that time. For institutions with $50 billion to $250 billion of assets (Level 2), senior executive defer 50% of their incentive-based pay for three years while risk-takers defer 40%. A third tier of institutions, those with $1 billion to $50 billion of assets (Level 3), are subject to enhanced disclosure requirements and more oversight from regulators.

Banks and credit unions are not the only financial firms subject to the rule — entities like mutual funds and certain hedge funds regulated by the Securities and Exchange Commission, the government-sponsored enterprises and beyond are all subject to compensation rules whenever they are finalized.

Michele Meyer, a director at Promontory Financial Group, said that even though the requirements are tougher for the largest institutions, the proposal's wide net will probably be most challenging to the larger midsize banks and the nonbank funds that have not had to go through these kinds of changes.

"It may have less impact on the very largest institutions, which have made moves in this direction in recent years that are generally consistent with key themes in the proposal," Meyer said. "But it's going to be a bigger change for other covered institutions, including Level 2 institutions and many SEC-regulated entities."

Both senior executives and "risk-takers" are also subject to policies allowing either a firm or a regulator the ability to reclaim incentive-based compensation if an individual's actions later turn out to have been based in fraud, deception or other malfeasance. Known as "clawbacks", these provisions are often commonplace in executive compensation packages today, though the proposal requires compensation to be subject to clawbacks for seven years, which is a longer timeframe than most such provisions currently in place.

The proposal would set a cap on total incentive-based compensation at 125% of target for executives at the largest institutions and 150% of target for a "significant risk-taker" at such institutions.

Bartlett Naylor, financial policy advocate for Public Citizen, said that he was encouraged by the wider net that regulators cast — and the hard line they appear to take. Still, he raised concerns it doesn't go far enough.

"This does affect a lot of people, tens of thousands of bankers are going to arguably have a methodology for their pay altered," Naylor said. "What we wanted was for it to be so dramatically different that it would attract an entirely new type of person to banking … someone who thinks that banks serve a social purpose."

The revised proposal — which is a multiagency regulation spanning the National Credit Union Administration, the Federal Reserve, the Federal Deposit Insurance Corp., the Office of the Comptroller of the Currency, the SEC and the Federal Housing Finance Agency — has been a long time coming. It had been widely expected to be released last year, but was delayed amid interagency disagreements. President Obama urged regulators to move faster on it during a meeting with them last month.

During a board meeting Thursday, NCUA Chair Deborah Matz — who is stepping down at the end of the month — acknowledged that getting to a reproposal was a journey.

"It's been a very long time coming, because on this controversial issue, it can be very difficult to develop a rule which meets the mandate of the law and at the same time is focused and fair," Matz said.